Real Money

Sunshine Despite Fear of Shadow Banking in China

Defaults are rare compared to the amount of lending in China.

TAIPEI (TheStreet) -- China's shadow banking field has cast a dark spell over markets as high-profile defaults become more common. Collapses of investments arranged through private trusts are spreading, making investors distrustful of China.

I'm stepping into some shadowy territory here, but I forecast the problem will fade, with little impact on capital markets.

Shadow banking, although around for a while, came to the world's attention last year. This month, when it turned out that products totaling $126 million issued by Jilin Province Trust in northeast China couldn't repay investors, some analysts started warning against positions in Chinese equities. The same trust and six others also had lent money to a defunct coal company, raising fears of a wave of new defaults.

"Unfortunately, due to a lack of transparency and the extremely complicated system, even well-informed global investors cannot grasp the true nature of China's financial difficulties," Nikko Asset Management of Japan said in a Jan. 30 research note. The note advises caution toward Chinese equities because of shadow banking risks, including government intervention that could dry up liquidity.

Investors presumably would get scared of a long-term, systemic problem and pull money out of Chinese markets to avoid being burned by companies nearing default. Poor sentiment onshore could leech into China-linked shares overseas, even well-run companies such as PetroChina Co. (PTR) and China Life Insurance (LFC).

But Nikko also points out a detail that lets you at least flip a coin about whether the issue will overshadow market performance. Defaults of several property trusts were settled because of rising land prices and "generous credit," its report says.

Look at this case, as told by the official Xinhua News Agency. In January, the news agency said, China Credit Trust reached a "last-minute deal" with investors to repay a $500 million investment in a mining operation that used the money to get loans it ultimately couldn't pay back. About 700 clients of the Industrial and Commercial Bank of China (1398.HK) had made the investment in the eventually bankrupt Shanxi Zhengfu Energy Group.